These 4 Measures Indicate That Zhen Ding Technology Holding (TPE:4958) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Zhen Ding Technology Holding Limited (TPE:4958) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhen Ding Technology Holding

What Is Zhen Ding Technology Holding's Net Debt?

As you can see below, Zhen Ding Technology Holding had NT$20.7b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has NT$38.9b in cash, leading to a NT$18.2b net cash position.

How Healthy Is Zhen Ding Technology Holding's Balance Sheet?

We can see from the most recent balance sheet that Zhen Ding Technology Holding had liabilities of NT$38.6b falling due within a year, and liabilities of NT$16.8b due beyond that. Offsetting this, it had NT$38.9b in cash and NT$24.6b in receivables that were due within 12 months. So it can boast NT$8.03b more liquid assets than total liabilities.

This short term liquidity is a sign that Zhen Ding Technology Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhen Ding Technology Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Zhen Ding Technology Holding has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhen Ding Technology Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhen Ding Technology Holding has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Zhen Ding Technology Holding recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Zhen Ding Technology Holding has NT$18.2b in net cash and a decent-looking balance sheet. So we don't have any problem with Zhen Ding Technology Holding's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zhen Ding Technology Holding has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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